TransDigm Group Incorporated: Fiscal 2019 Third-Quarter Form 10-Q
Reporting period: Thirteen and thirty-nine weeks ended June 29, 2019, compared with the periods ended June 30, 2018. The interim financial statements are unaudited. TransDigm designs, produces and supplies highly engineered aircraft components across commercial, defense and non-aviation markets. The March 14, 2019 acquisition of Esterline materially affects comparability.
Financial Performance and Liquidity
| Metric | Q3 FY2019 | Q3 FY2018 | YTD FY2019 | YTD FY2018 |
|---|---|---|---|---|
| Net sales | $1,658.3 million | $980.7 million | $3,847.6 million | $2,761.7 million |
| Gross profit | $761.5 million | $569.5 million | $1,984.9 million | $1,580.2 million |
| Gross margin | 45.9% | 58.1% | 51.6% | 57.2% |
| Income from operations | $445.0 million | $437.5 million | $1,338.6 million | $1,200.2 million |
| Net income attributable to TD Group | $144.5 million | $217.2 million | $542.9 million | $728.3 million |
| EPS | $2.57 | $3.91 | $9.22 | $12.09 |
| EBITDA As Defined | $691.0 million | $487.1 million | $1,749.4 million | $1,351.8 million |
| EBITDA As Defined margin | 41.7% | 49.7% | 45.5% | 49.0% |
Q3 sales increased 69.0%, comprising 11.8% organic growth and 57.2% acquisition sales. Year-to-date sales increased 39.3%, comprising 11.5% organic growth and 27.8% acquisition sales. Organic growth was led by defense, commercial OEM and commercial aftermarket demand.
Q3 net income declined 33.5% and year-to-date net income declined 25.5%. Margin pressure primarily reflected Esterline inventory acquisition accounting adjustments, acquisition integration costs, foreign-currency losses, higher amortization, increased stock compensation and higher interest expense. Q3 included $88.9 million of inventory step-up amortization; year-to-date included $109.3 million.
Net cash provided by operating activities was $768.4 million year-to-date, compared with $690.9 million in the prior-year period. Capital expenditures were $80.4 million. Acquisition payments were $4.0 billion, principally for Esterline. Cash and cash equivalents totaled $2.717 billion at June 29, 2019, up from $2.073 billion at September 30, 2018.
Debt, Capital Structure and Liquidity
- Net long-term debt was $16.496 billion at June 29, 2019, compared with $12.502 billion at September 30, 2018; total debt including the trade receivable securitization facility was approximately $16.877 billion before related discounts and issuance costs.
- The company issued $4.0 billion of 6.25% secured notes due 2026 and $550 million of 7.50% subordinated notes due 2027 to finance the Esterline acquisition and related transactions.
- The $550 million 2020 notes were redeemed in March 2019, and approximately $373.8 million of Esterline 2023 notes were redeemed in April 2019.
- The term-loan facility had $7.543 billion outstanding and the revolving facility had $726.0 million of borrowing capacity available, subject to covenants; $34.0 million of letters of credit were outstanding.
- The company had $300.0 million outstanding under its trade receivable securitization facility and $50.0 million of unused capacity at June 29, 2019. The facility was subsequently extended to July 28, 2020.
- Management stated that the company was in compliance with all debt covenants at quarter-end and expected operating cash flow and available borrowing capacity to meet obligations and liquidity needs.
Material Changes and Unusual Items
- Esterline acquisition: The transaction contributed $545.3 million of Q3 sales and $670.3 million of year-to-date sales. Preliminary purchase accounting added approximately $2.5 billion of goodwill and $1.0 billion of intangible assets; valuation remains subject to adjustment during the measurement period.
- Segment integration: Esterline operations were integrated into the Power & Control, Airframe and Non-aviation segments rather than being reported as a separate segment.
- Government refund: Selling and administrative expense included a $16.1 million voluntary refund to several U.S. Department of Defense agencies.
- Accounting adoption: ASC 606 was adopted using the modified retrospective method, increasing retained earnings by $3.3 million; management reported no material impact on current-period results. ASC 842 lease accounting was scheduled for adoption on October 1, 2019, with the impact still under evaluation.
- Backlog: Estimated backlog was $3.856 billion at June 29, 2019, compared with $2.018 billion at June 30, 2018. Most orders were expected to ship within 12 months, although orders may be canceled or deferred.
Outlook, Commentary and Risks
Management emphasized organic growth across defense, commercial OEM and aftermarket markets and continued application of its value-driven operating strategies. It expected these strategies to support strong margins and operating cash flow sufficient to meet interest and liquidity needs. The filing does not provide a specific revenue, earnings or EBITDA forecast.
Key risks include high leverage and refinancing requirements; interest-rate exposure on floating-rate debt; integration and valuation risks related to Esterline; dependence on aircraft flight hours, airline profitability and defense spending; customer concentration; government-contracting and pricing scrutiny; foreign currency, international operations and geopolitical risks; raw-material, labor and tax costs; cybersecurity and natural disasters; litigation and environmental liabilities; and the ability to maintain required regulatory and industry approvals.
Pending or subsequent transactions included a binding offer to sell the Souriau-Sunbank businesses to Eaton for approximately $920 million, an agreement to sell Esterline Interface Technology businesses for approximately $190 million, and a declared $30.00-per-share special dividend with total cash payments of approximately $1.7 billion, all expected or scheduled in the first quarter or fourth quarter of fiscal 2019 as described in the filing.
The company disclosed securities class-action and shareholder derivative litigation concerning alleged disclosures and business practices related to U.S. government sales. Management believes the matters lack merit and expects insurance coverage, but stated that potential outcomes and losses cannot yet be estimated reliably.
Important Facts for Investors to Verify
- Separate the underlying organic performance from acquisition-driven growth and assess the sustainability of post-Esterline margins.
- Reconcile GAAP earnings and cash flow with EBITDA As Defined, including the substantial add-backs for inventory step-up, acquisition costs and stock compensation.
- Evaluate leverage, interest expense, floating-rate exposure, maturities and covenant headroom after the Esterline financing and special dividend.
- Confirm completion, proceeds and use of funds from the Souriau-Sunbank and Esterline Interface Technology divestitures.
- Monitor the final Esterline purchase-price allocation, intangible amortization, integration costs and potential impairment exposure.
- Assess the impact of the Department of Defense refund, government-contracting scrutiny and pending litigation.
- Verify the effect of the special dividend and subsequent cash position on liquidity and debt-repayment capacity.